What's Really Going on With Bonds? LIBOR Rates Have the Answer

LIBOR rates matter more to the economy than 10-year or 30-year Treasury rates, and they express a more global view.

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I've always believed that investors need to pay attention to what the bond markets are telling us. However, simply following headline news can create more confusion than clarity. In the past month, we've seen stories about how the US Federal Reserve may cut bond buying by fall, mortgage rates have risen half a percent, and 10-year Treasuries are up nearly as much.

It seems simple to see that bond yields are spiking. But the story is really much deeper. I, for one, think the secret to understanding what's happening with bonds is to pay close attention to LIBOR rates. Why LIBOR? Most consumer loans -- including car loans, many credit cards, and adjustable rate mortgages -- are based on LIBOR rates. As such, these matter much more to the economy than the 10-year or 30-year Treasury rates.

As the chart below shows, LIBOR rates have been steady in the past month but are down significantly from a year ago.

I'm not trying to dismiss the idea that the 35-year-long bond market bull run is over; to the contrary, I'm surprised bonds have done so well for so long.

Nonetheless, I'm a bit perplexed at the current level of hyperbole regarding the "mini" correction we are seeing in US Treasury markets. Here's another reason why LIBOR is valuable: It expresses a more global view versus a more US-centric view.

When I look around the world, I see plenty of trouble spots and reasons to be nervous about the long-term outcome of all the currency and interest manipulation that is occurring as a result of central bank actions.

What I don't see is a reason to panic or any indication that a sizeable shift in monetary policy is likely anytime soon. Japan may reverse course on some of its aggressive measures, but Europe is likely going to ease more, and the US is unlikely to change track soon.

A reversal of shift in policy in Japan is likely to shake markets, but in my view, this would prove very constructive for US equities. Why? I like to use the analogy of drinking a gallon of water. If I told you to drink a gallon of water in an hour, you could do it without too much difficulty. If I asked you to do this in 10 minutes, you would likely drown.

Japan is drowning -- and it is not because the policy is wrong, but rather because the system is unable to digest the swiftness and brute force of the policy. I am (somewhat) a believer in rational market theory, and I believe that market participants will come around to this view in the coming months.

As such, I don't see a reason to panic, and believe that Treasury yields will retreat again. As for how that will translate in terms of US equities, I see them trading 4% to 5% above current levels by Thanksgiving.